Dow hits record, erasing losses during recession

NEW YORK -- Five and a half years after the start of a frightening drop that erased $11 trillion from stock portfolios and made investors despair of ever getting their money back, the Dow Jones industrial average has regained all the losses suffered during a lengthy recession and reached a new high.

The blue-chip index rose 125.95 points Tuesday and closed at 14,253.77, topping the previous record of 14,164.53 on Oct. 9, 2007, by 89.24 points.

The last time the Dow hit a record, George W. Bush still had another year as president, Apple had just sold its first iPhone and Lehman Brothers was still in business.

"It signals that things are getting back to normal," said Nicolas Colas, chief market strategist at ConvergEx Group, a brokerage. "Unemployment is too high, economic growth too sluggish, but stocks are anticipating improvement."

The record suggests investors who did not panic and sell their stocks in the 2008-2009 financial crisis have fully recovered. Those who have reinvested dividends or added to their holdings have done even better. Since bottoming at 6,547.05 on March 9, 2009, the Dow has risen 7,706.72 points, or 118 percent.

Unemployment also was 4.7 percent versus 7.9 percent today, a reminder that stock gains have proved no elixir for the economy.

The Dow record does not include the impact of inflation. Adjusted for that, the Dow would have to reach 15,502 to match its old record.

The Standard & Poor's 500, a broader index, closed at 1,539.79, 25.36 points from its record.

Still, the Dow high is another sign the nation is slowly healing after the worst recession since the 1930s. It comes as car sales are at a five-year high, home prices are rising, and U.S. companies continue to report big profits.

The stock gains have helped retirement and brokerage accounts held by many Americans recover. That, in turn, has helped push U.S. household wealth nearly back to its peak before the recession, though many in the middle class are still deep in the hole. Most middle-class wealth is tied up in home values, which are still a third below their peak.

Good economic news Tuesday helped lift stocks. Retail sales in the 17 European countries that use the euro rose faster than expected, China's government said it would support ambitious growth targets, and a report showed U.S. service companies grew last month at their fastest pace in a year.

"It feels great," said Marty Leclerc, chief investment officer at Barrack Yard Advisors, an investment firm. In early 2009, when stocks were plummeting, "it looked like Armageddon was nigh. It's a lot more fun to be in a rising market."

In the depths of the recession four years ago, few investors would have predicted such a fast recovery. Some feared another Great Depression. Banks were collapsing, lending was frozen, world trade was plunging, and stocks were in free fall.

"People thought we were going to relive the 1930s," says Robert Buckland, chief global stock strategist at Citigroup. He calls the stock gains since "pretty remarkable."

From its peak in October 2007 to its bottom in March 2009, the Dow fell 54 percent. That was far less than the nearly 90 percent drop in the Great Depression but scary nonetheless. There had been 11 previous bear markets since World War II and none had reached 50 percent.

One man who stayed calm and didn't sell was Jay Sachs, 70, a retired computer consultant. In fact, as others scrambled to exit stocks in late 2008, he plunged in more -- scooping up drugmaker Eli Lilly and Co., health-care products giant Johnson & Johnson and food company General Mills.

"You have to be greedy when others are fearful," he says, quoting a famous line from billionaire Warren Buffett, who also bought in the panic. Sachs adds, "People are still fearful and that's a good sign. There's room for growth."

He says his portfolio has doubled in value in four years.

As stock rebounds go, this has been an unusually quiet and uncelebrated one. Typically, bull markets are accompanied by rising trading volume, a surge in young companies going public and Internet chatter over hot stocks.

The past four years, none of that has happened.

Adding to the chastened mood is lingering fear among many investors that stock gains can disappear in a flash. Burned by two stock-market crashes in less than a decade, Americans have sold more U.S. stocks than they've bought the past four years, nearly unprecedented in a bull market since World War II.

In this run-up, nearly all the buying has come from companies repurchasing their own stock in an effort to boost its value. Companies in the S&P 500 have bought $1.5 trillion since the Great Recession began in December 2007.

Dow records are dismissed by some investors as unimportant because the index comprises just 30 stocks. Many professional investors prefer to follow the S&P 500, which, as the name implies, tracks 500 companies. But the Dow has closely followed the ups and downs of its broader rival over the years, and is a good proxy for how big companies are doing.

The S&P 500 is up 128 percent from its March 9, 2009 low, about the same as the Dow.

The Dow record is a victory of sorts for Federal Reserve Chairman Ben Bernanke. Under his aegis, the Fed launched an unprecedented campaign to lift stocks by making their chief rival for investor money -- bonds -- less attractive.

Under a program called "quantitative easing," the Fed has bought trillions of dollars of bonds to drive their yields down. The idea was that the puny yields would so frustrate investors, they'd have no choice but to shift into stocks. That, in turn, would push up stocks and make people feel wealthier and more willing to spend, helping the economy.

Just as Bernanke had hoped, American household wealth, or assets minus liabilities, has risen, though the gains haven't been shared equally.

In the recession, household wealth fell $18.9 trillion, or 28 percent, as the prices of assets like stocks and homes tumbled. But after bottoming in the first quarter of 2009 at $48.5 trillion, wealth rose $16 trillion through the third quarter of last year and was within striking distance of its peak of $67.4 trillion, according to the latest data from the Federal Reserve. Gains since then may have pushed wealth to a new high.

Middle-class households have not recovered as much as those numbers suggest because most of their wealth is tied up in their homes, and home values haven't bounced back like 401(k) accounts.

Homes accounted for two-thirds of middle-class assets before the recession, estimates economist Edward Wolff of New York University. By contrast, they accounted for one-third of assets of all U.S. households. Stocks were 7 percent of middle-class assets, less than half the percentage for all.

The rich have been the biggest winners of this bull market. Eighty percent of all stocks are held by the wealthiest 10 percent of households. If per-share earnings keep growing, stock prices could go up too, and the P/E ratio would stay the same. And there have been many periods in which P/E ratios rose well above the long-term average. Such "multiple expansion," as market watchers refer to a rising P/E ratio, would mean stock prices would be even higher.

To stock bulls, the economy is on the verge of what Bernanke calls "escape velocity," a self-sustaining pace of growth and better than the sluggish 1-2.5 percent of the past three years. Faster economic growth would boost corporate earnings, which would lead to higher stock prices.

Of course, if investing was as simple as looking up interest rates and stock valuations, we'd all be rich. Plenty can go wrong.

For starters, future earnings, the biggest driver of stock prices, could prove disappointing. Financial analysts expect earnings for the S&P 500 to grow a healthy 8 percent this year, according to FactSet, a provider of financial data. Most of that increase is expected in the last half when they assume economic growth accelerates.

Will that happen? It's anyone's guess, and financial analysts are often too bullish. A year ago, they expected a 13 percent jump in earnings in the last three months of 2012. They got 4 percent instead.

Investors also need to pay attention to what's happening in the rest of the world. Big U.S. companies generate nearly half their revenue from overseas. The 17 European countries that use the euro as a currency have been in recession for more than a year. Japan, the world's third-largest economy, fell into one late last year. Stock markets tend to look ahead, so what matters is whether the recessions deepen in Europe and Japan or those economies start growing again.

Another worry is what will happen after the Federal Reserve stops stimulating the U.S. economy. Last month, minutes of the Fed's last policy meeting were released, and they showed members disagreeing on when to stop. The Dow lost 155 points in two days.

Jeff Sica, founder of money manager Sica Wealth Management, says the rising market is good because it's a sign of confidence. But he fears stocks could sink when the Fed stops buying bonds.

It's a big "psychological reason the market is going up," he says. "People know the Fed will continue to inflate assets."

The Fed stimulus was in response to the worst economic recession since the 1930s.

The Great Recession began in December 2007, two months after the Dow and S&P 500 reached their peaks in October. It was triggered by a drop in home prices that hammered consumers and banks. Nine months later, in September 2008, Lehman Brothers declared bankruptcy and lending froze worldwide.

Panicked investors began pulling money out of stocks. Prices, which had been falling slowly, nose-dived. By March 9, 2009, the Dow had fallen 54 percent and the S&P 500 57 percent.

In total, $11 trillion in stock wealth, or 12 years of stock gains, was wiped out in 17 months.

Despite widespread fear then, the history of bear markets was encouraging. In the second- and third-worst bear markets since World War II, the S&P 500 fell 49 percent in 2000-02 and 48 percent in 1973-74. Both times the climb back took less than six years.

But few people believed four years ago that the return would be so fast.

A few days after stocks bottomed, a BusinessWeek cover story laid out three scenarios for regaining the losses. The most pessimistic held that stocks would notch 6 percent gains each year and the Dow would return to its old high in 2022, 13 years later. The most optimistic assumed 10 percent annual gains and saw a return in 2017, eight years later. The Dow has rebounded in about half the time as the most optimistic case.

The climb hasn't been smooth, though.

In May 2010, a trading glitch set off a so-called flash crash that sent the Dow plunging 600 points in five minutes. In August 2011, stocks yo-yoed for several days on fears that the U.S. would default on its debt. Over three weeks, the Dow plunged 2,000 points. Beginning last October, the Dow fell 1,000 points over six weeks on worries that a budget deal wouldn't get passed and the economy would go over the "fiscal cliff."

But the Fed's bond buying and the ability of companies to produce record profits helped the market overcome every setback.

In the turbulent journey to new highs, Wall Street strategists and other experts have predicted many times that small investors were about to fall in love again with stocks. The "dry powder" of their money would set fire to an already hot market. After all, small investors had helped push stocks up in the great bull market of the `80s, which began in August 1982. Those who had left the market years earlier began buying again, and stocks more than tripled in five years.

They drove a bull market again in the 1990s. Stocks more than quintupled in 9 1/2 years.

But small investors have not only stayed away the past four years, they have sold hundreds of billions of dollars of stocks.

Then, in January, as the Dow inched closer to its record, individual investors seemed to have second thoughts. They put nearly $20 billion more into U.S. stock mutual funds than they took out in January, according to the Investment Company Institute, a trade group for funds.

It was just a trickle, but it may have helped stocks surge. In January, the Dow rose 5.8 percent, and the S&P 500 rose 5 percent. It was the best start to a year for the Dow since 1994.

For good or ill, it's possible the Dow's new high might convince investors to put more money into stocks.

"When you hear about new highs, the greed factor kicks in," says Colas, the ConvergEx Group strategist. "It gets people to think, `Do I own enough stocks?"'

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Follow Bernard Condon on Twitter at http://twitter.com/BernardFCondon.